With Interest Rates on Many Loans Set to Double Soon, The Dischargeability of Student Loans in Bankruptcy is a Crucial Issue for Future College Students

Student loan debt is one of the largest forms of personal debt in America, surpassing the total amount of credit card debt in some estimates. With the costs of education rising and overall job prospects improving only slowly, student loan debt is likely to continue to be a tremendous weight on the shoulders of college graduates, current college students, and future students. Discharge of student loan debt in bankruptcy is extremely difficult, requiring a showing of “undue hardship” according to strict definitions. In addition to the difficulties student loan debtors already face, Congress has failed to pass legislation regarding interest rates on new federally-subsidized student loans. This means that interest rates on subsidized loans made on or after July 1, 2013 will double from the current level. Legislation is currently pending in Congress that would allow discharge of student loans in bankruptcy and lower the interest rate on new loans.

The interest increase will affect subsidized Stafford student loans, which are available to undergraduate students who demonstrate financial need. As long as the debtor is enrolled in an undergraduate program at least part-time, the U.S. Department of Education pays the interest on the loans. It also pays the interest during the “grace period,” which lasts for six months after leaving school, and during any approved deferment of loan payments. The current interest rate paid by debtors during any other time period is 3.4 percent, but it is scheduled to double to 6.8 percent on July 1.

The rise in student loan interest rates is likely to make a bad situation even worse, particularly with regards to people who seek bankruptcy protection. At least two bills are currently pending in the U.S. Senate that are intended to alleviate the problem. Senator Elizabeth Warren (D-MA) introduced S. 897, the Bank on Students Loan Fairness Act, on May 8, 2013. This bill would lower the interest rate on subsidized Stafford student loans to 0.75 percent, which Senator Warren says is the same interest rate paid by large banks on loans from the Federal Reserve. This would not address the corresponding issue of the ever-increasing cost of a college education, but it would allow people who are planning to take out student loans after July 1 to avoid significantly higher amounts of debt.

While the interest rate increase may only affect people receiving federally-subsidized student loans, the exception of student loans from discharge in bankruptcy affects all student loan debtors. Senator Richard Durbin (D-IL) introduced S. 114, the Fairness for Struggling Students Act of 2013, in January, and it has been waiting in the Senate Judiciary Committee ever since. This bill would address the bankruptcy issue head-on by amending the bankruptcy code to allow discharge of student loan debts without “undue hardship,” with the exception of federally-subsidized loans. Since government loans are already excepted from discharge in bankruptcy, this would make private student loans subject to many of the same rules as other personal loans.

Bankruptcy gives people in financial distress a way to restructure their bills, or even discharge their debts entirely. Bankruptcy attorney Devin Sawdayi has represented clients in bankruptcy cases in the Los Angeles area since 1997, helping them restructure their finances with dignity and respect. To schedule a free and confidential consultation, contact us today online or at (310) 475-9399.